Investment strategies for volatile markets

GLOBAL INVESTOR 3.07 Special — 39
20% is generated by security selection and transaction timing.
This is precisely where total return strategies seek to excel: they
strive always to be invested in the asset classes with the best
return potential. Broad allocation ranges allow portfolio managers
to selectively increase or decrease exposure to each asset
class. Portfolio managers can even shun an asset class entirely
if its return potential looks doubtful or insufficient. Derivatives
(futures, options, swaps) and exchange-traded funds add even
more flexibility to the investment strategy because these instruments
can be used to alter the portfolio asset mix within a very
short period of time, and they also permit quick reactions to any
upward or downward trends. For example, when stockmarkets
started to correct by the end of February 2007, the equity allocation
in the portfolios could be reduced by means of derivative
instruments. Later, these hedges were liquidated at a profit and
the equity exposure increased again.
Figure 1
The total return concept
The concept for a professional and successful implementation of
all total return strategies is based on three major key drivers: wide range
of performance contributors, transition to a flexible asset allocation
and a very rigorous risk management. Source: Credit Suisse Asset Management
1.
Broad range
of return drivers
3.
Stringent risk management. Due to the large number of sources
of return and the extremely flexible investment strategy, effective
risk management is imperative in order to ensure capital
preservation during periods of market stress. Therefore, a risk
budget has been defined for every total return solution based
upon the concept of value-at-risk (VaR; see explanation on page
40). But even the value-at-risk concept entails certain assumptions
and cannot accurately capture extreme market events.
Consequently, more thorough (risk) analyses are performed. In
so-called stress tests, simulations such as a 10% stockmarket
correction or a 1% rise in interest rates are performed to determine
what impact this would have on the portfolio. “Expected
shortfall” is another method used to quantify the expected loss
in these extreme situations that are not captured in the risk
budgets. Many investors might think that such analyses are very
technical and theoretical. But in practice they are very useful for
portfolio managers. For example, planned portfolio transactions
are first simulated and the effects of these transactions on a
portfolio’s risk structure and their expected return contribution
are calculated. Transactions are then implemented in the portfolio
only if the corresponding risk/return profile is positive.
3.
Strict risk
management
Total return
strategies
2.
Flexible
investment strategy
Investment process designed for flexibility
Total return strategies pose major challenges in the investment
process. On the one hand, the medium- and long-term financial
market outlook determined by Credit Suisse Asset Management
needs to be taken into consideration in the tactical asset alloca-